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Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 7 - Evidence - April 2, 2014


OTTAWA, Wednesday, April 2, 2014

The Standing Senate Committee on Banking, Trade and Commerce met this day, at 4:55 p.m., to study the use of digital currency.

Senator Irving Gerstein (Chair) in the chair.

[English]

The Chair: I want to mention to the members that I would appreciate it if you would be good enough to remain for about five minutes in camera at the conclusion of the meeting.

Today the committee is holding its third meeting as part of its study on the use of digital currency. The committee began its study last Wednesday with an appearance by officials from the Department of Finance, followed on Thursday by two members of academia, both of whom have worked in the areas of private and digital currencies.

This afternoon the committee will be receiving a presentation from the Bank of Canada. We are pleased to welcome Grahame Johnson, Chief, Funds Management and Banking; and Lukasz Pomorski, Assistant Director, Funds Management and Banking.

Thank you both for being here today. We apologize for being a little late in getting starting.

My understanding, Mr. Johnson, is that you will start with an opening statement and Mr. Pomorski will follow with a technical briefing on digital currency.

Mr. Johnson, the floor is yours.

Grahame Johnson, Chief, Funds Management and Banking, Bank of Canada: Thank you, Mr. Chair. Both Lukasz and I would like to thank all the committee members for the invitation to speak today. It is a subject that we both find to be complex but fascinating. As you know, the bank was asked to provide you with a briefing on digital currencies and we are happy to be here today to do so.

In discussing digital currencies, it might be helpful to put them in the context of advances in the payment system more broadly. Given that, I'll start by providing an overview of recent innovations and developments in payment systems and the role of the Bank of Canada. Then my colleague, Lukasz Pomorski, will provide you with more technical details about digital currencies and the needs they serve.

Our briefing today is intended to provide some background on what e-money is and how it is evolving. While we will introduce some of the policy issues that the broad adoption of e-money could raise for the Bank of Canada, it is important to stress that our research in this area is still very much a work-in-progress and many, if not all, of the policy issues remain open questions. We would, however, be pleased to return to this committee at a later date and speak to the policy questions in more detail once our work is further advanced.

As anyone who has visited the Currency Museum at our previous location on Sparks Street will know, systems of payment have evolved over time to meet the needs of the society they serve. Within this context, we can see that digital currencies, or e-money and similar innovations, are part of this broader historical continuum.

Before I discuss some of these innovations, I would like to start with some basic definitions about what exactly it is we mean by "money." Money serves three functions. First, it's a generally accepted medium of exchange. You can change your Canadian dollars for a coffee or a sandwich, for example, and the person who sells you the coffee can in turn use the money received to buy other goods. This general acceptance is a critical that money needs to play.

Second, it serves as unit of account. The dollar helps us to compare the value of different goods, for example, the cost of a Tim Hortons coffee compared with a Starbucks coffee.

Third, it can be used as a store of value. You can deposit your dollars in your bank account and then be confident that when you withdraw them, they still will have a similar value in terms of the goods or services that they can purchase.

[Translation]

We are all very familiar with money in the traditional sense, that is to say coins and bank notes. When we talk about Canadian dollars we usually have Canadian bank notes in mind. These notes, once paper and now polymer, remain popular among Canadians; the value of notes in circulation has been growing at more or less the same pace as the economy over the past two decades. So, despite a growth in electronic payments, cash is still important.

Important, but not always convenient. Carrying bank notes to pay for purchases, especially for transactions that have a relatively large value — like buying a refrigerator or a car — can be impractical. There is also the risk of loss or theft. Over the years, innovations in payment systems have addressed many of these problems.

[English]

In the modern financial system, people typically store their money as deposits in commercial bank accounts. This money is denominated in state currencies and issued by regulated financial institutions through lending and the creation of demand deposits; that is, accounts that allow people to access their money on demand. Demand deposits are a medium of exchange and can be transferred from one account holder to another. Cheques were an early innovation that facilitated such transfers. They save us the hassle of going to the bank to withdraw large sums of cash.

Since the introduction of cheques, we have seen a number of other technological advances that allow the transfer of account balances between people and between people and businesses. These innovations include such things as debit and ATM cards, phone banking, Internet banking and mobile banking, all of which we refer to as access devices; that is, they provide access to our demand accounts, but they are not money per se.

I should also mention the innovation of the credit card, which we use to transfer funds from our credit account at a bank. Again, credit cards are access devices in that they provide us access to lines of credit.

For our discussion, we will refer to such access devices as electronic payments or e-payments. We continue to see innovation in e-payments. More recently, for example, we've seen the introduction of contactless debit and credit cards. These are the tap-and-go cards that you may have seen. Such improvements are driven by the evolving needs and expectations of consumers but also by advances in technology. Importantly, e-payments are the domain of banks and other deposit-taking institutions that are subject to prudential regulation.

From e-payments I will move to the main topic of our presentation: e-money. In contrast to e-payment technology, e-money is actual monetary value that is stored on an electronic device. This could be a computer, a mobile phone, a tablet, a chip card or even a server, in a cloud. It has a monetary value in a state currency, often from an issuer who assumes a liability for that value. In this way it's different from e-payments that don't have that intrinsic value but, rather, provide access to funds in a bank account.

Lukasz will provide you with a much more detailed analysis of what e-money is and what the main types of e-money are, but e-money was developed and is growing for reasons that are related to both demand and supply.

On the demand side, online commerce has clearly created the need to be able to transact over long distances using telecommunication technology. While existing e-payment methods such as credit cards can and clearly are used for such online transactions, they carry with them a number of potential disadvantages, for example, inconvenience and, in the case of credit cards, the need to share a relatively large amount of information every time a transaction occurs. There are relatively high fees. Again in the case of credit cards, merchants get charged for every transaction, particularly for small-value transactions that can be prohibitive. Certainly, cross-border transactions or international remittances are expensive. Finally, there are potential security risks, many associated with the amount of information that needs to be disclosed.

On the supply side, there are things such as advances in technology, the growth of the Internet and the widespread adoption of technology such as mobile devices and smart phones, which give people the means to use these new payment products offered by technology companies. We now have firms such as PayPal, for example, that allow users to pay over the Internet without giving a full amount of personal information to the merchant with every transaction. E-money can also make payments more efficient and cheaper, especially across borders.

While e-payments are facilitated by regulated financial institutions offering new ways for individuals and businesses to transfer money, e-money itself is often issued by unregulated institutions. These include new players in the payments landscape: telecommunications companies, information processers and even, in some cases, social networks.

While banks still provide payment services, they often seek partnership with non-banks in providing innovative payment products such as mobile payment.

[Translation]

How important are these innovations to the Canadian economy? A 2009 study conducted by the Bank of Canada showed that two particular innovations, contactless credit cards and stored-value cards, accounted for three per cent of the number of transactions and about two per cent of the dollar value of all transactions. This relatively small share may have increased over the past few years, and the bank is currently updating this research.

Moreover, the Canadian Payments Association estimated that there were 24 million transactions of various e-money products in 2011, worth nearly $10 billion, up from $3 billion in 2008. These figures likely capture only a subset of all e-money transactions as the CPA tracked only e-wallet products and peer-to-peer transactions. Over the same period, the annual growth rate of these types of payments in terms of volume has averaged close to 40 per cent.

[English]

Despite this growth, there are relatively fewer e-money products in Canada relative to some other countries. Some of you may remember Mondex — although neither of us do — which was a stored value card that appeared in the mid-1990s but failed to get traction. This seems to suggest that Canadians are relatively well served by the existing methods of payment and existing methods of e-payment systems in particular.

In contrast, consumers in countries with retail payment systems that are not as well developed need to seek out alternative methods of payment. This leads to e-money innovations such as the mobile system M-Pesa in Africa or multi-purpose prepaid cards such as the Octopus card in Hong Kong.

E-money addresses important consumer needs but also raises potential risks and challenges. At present such risks have the largest impact on individual consumers and businesses rather than on the overall Canadian economy or financial system.

The most significant risk posed by e-money is probably inadequate user protection. This could include insufficient or inadequate information about a new payment service provider, especially about terms and conditions, fees or dispute settlement procedures. Moreover, users may not fully appreciate the potential privacy issues associated with these means of payment since some e-money providers have business models that depend on advertising revenue derived from sharing personal information about users.

Other e-money developments provide relative anonymity which entails additional risks such as money laundering and terrorist financing issues. I believe our colleagues from the Department of Finance, who appeared here last week, have discussed these aspects of e-money in a little more detail.

The Bank of Canada has several reasons to be interested in e-money developments. The bank designs, produces and distributes Canada's banknotes. One potential impact of recent developments in e-money is that they may lead to changes in the demand for cash. There are at present about $63 billion worth of banknotes in circulation and the bank invests the proceeds of issuing these notes in Government of Canada bonds. These bonds are held on the bank's balance sheet and generate interest income, which we refer to as seigniorage revenue. This revenue is used by the Bank of Canada to pay our expenses and the balance is remitted to the federal government. In 2013 this seigniorage revenue was roughly $1.6 billion and the remittance to the government was about $1 billion.

Furthermore, the financial assets of these government bonds that we hold on the bank's balance sheet help support the bank's various mandates, including our monetary policy and financial stability functions. A substantial decrease in the demand for cash would mean a commensurate increase in the financial assets on the bank's balance sheet. This would, in turn, lead to reduced revenue for both the bank and the federal government. Furthermore, the lower level of financial assets held on the balance sheet might also have other effects on the bank's ability to do the work we do. Given that the demand for cash has been relatively stable over the past number of decades, these risks at present appear to be largely hypothetical.

The bank also has an interest in promoting safety and efficiency in the payment system. We work with other authorities in this area, and given the bank's responsibilities under the Payment Clearing and Settlement Act, we are collaborating with the Department of Finance to conduct a governance review of the payment system. This work addresses the oversight and governance of the national payments, clearing and settlement infrastructure and includes alternative payments technology.

Studying e-money and its implications for central banks is clearly a strategic priority for the Bank of Canada. The bank's research efforts in this area are focused on deepening our understanding of electronic money and payments as digital alternatives to cash, and analyzing the implication of an increased use of these alternatives for how the bank fulfills its mandates to provide secure banknotes, to promote financial stability, and to control inflation.

Our research will inform a number of important policy questions. These include: Should the Bank of Canada have a role as an issuer or operator of e-money? Could the broader adoption of e-money pose financial stability concerns? If so, how can these be best mitigated? What is the appropriate regulatory framework for e-money? Could increased reliance on e-money potentially have implications for monetary policy?

As I mentioned at the beginning, it is important to stress that our research in this area is very much a work-in-progress, and the issues I've raised remain open questions. Given the public interest and the importance of the topic, however, the bank intends to share its research with the public through a new section on our website dedicated to this subject, and the bank sees e-money within a broader continuum of payment system innovation. As with any innovation, looking back at where we have been is a lot easier than looking ahead to determine where we're going. With a solid research agenda and by monitoring and assessing e-money systems, the bank is committed to building our understanding so we continue to meet our mandate to promote the economic and financial welfare of Canada.

I will now turn it over to Lukasz for an in-depth explanation of e-money.

Lukasz Pomorski, Assistant Director, Funds Management and Banking, Bank of Canada: Let me start by saying that e-money is difficult to define. When you talk to people about it, multiple terms are used almost interchangeably: e-money, e-cash, digital money, digital currency, virtual currency and so on. The problem is that people would use these terms with sometimes very different meanings. We'll talk about that. Then we'll talk about whether and how e-money could potentially satisfy the roles of money and currency, as we understand it, in terms of a medium of exchange, a unit of account and a store of value.

As Grahame explained, e-money is monetary value stored on an electronic device, either a computer, mobile phone, tablet or chip card.

To analyze it more deeply, I would like to divide e-money into two categories: One is centralized e-money, that is, e-money that is issued and often managed by a central issuer who often assumes liability for the e-money; and decentralized, that is, based on a dispersed network of users, with no one user recognizing the e-money as his liability.

I will begin with centralized e-money. Centralized e-money is monetary value stored on an electronic device that is issued upon receipt of funds and accepted as a means of payment by entities other than the issuer.

This definition is used not only by us but also by multiple other institutions, for example, the European Central Bank or the Bank for International Settlements. The critical feature of centralized e-money is that it has a particular issuer who has liability for its value.

As an example, consider prepaid payment cards, for example, those issued by Visa or MasterCard. Consumers who are using these cards could use the card potentially to obtain a particular good or service from the issuer directly. They might use the card for goods and services provided by a third party — for example, a merchant — who will subsequently be reimbursed by the issuer. Lastly, the consumer might also be able to redeem the value of e-money perhaps using an ATM, and the cash will be subsequently reimbursed by the issuer to the bank.

Another important and key feature of centralized e-money is that it is multipurpose. Prepaid cards that are used for a particular store or coffee chain wouldn't qualify for that.

To give you an example of a very popular centralized e-money device, I would like to talk about the Octopus card, which is very popular in Hong Kong. The Octopus card is a contactless card that is prepaid and was originally issued by the Hong Kong mass transit system. Over time, the Octopus card has become more generally accepted by retailers, and nowadays people use it to make other purchases, not only transport. Value on the Octopus card is prepaid and it becomes a liability of the issuer. It can be used to make payments at a wide range of retail and transport venues, which satisfies multi-purpose criteria.

I would like to contrast the Octopus card with a similar card that we have in Canada, the PRESTO card. The PRESTO card is used for transport services in multiple municipalities in Ontario. At present, the acceptance of a PRESTO card is limited to the transport system. You can use it to pay for rides but not necessarily to make purchases for coffee, newspapers and so on.

When we compare the PRESTO and the Octopus card, there's an interesting question: Why did the Octopus card, quite similar to PRESTO, gain widespread adoption in Hong Kong and is used for a variety of purposes, whereas in Canada it's used almost exclusively for transport?

In Hong Kong, since the 2000s, consumers have been using the Octopus card not only for transport but also for small transactions. In Canada, this is not so. One reason is that in Canada, contactless debit and credit cards are already filling this economic need, this niche.

One last point that I want to make on the topic of centralized e-money is that sometimes when you talk to people about that, they would mention centralized digital currencies that are issued by particular Internet companies, for example, Facebook or Amazon, or used within some computer game systems, for example, World of Warcraft. Those currencies are actually centralized in the sense of being issued and controlled by a particular company.

We would argue, however, that they don't really qualify as e-money. The key reason why not is because they are intended to be used exclusively within those platforms and communities. They are in no sense generally accepted as a medium of exchange, as means of payment, and hence don't qualify as e-money.

Having talked about the centralized variety of e-money, let us move on to decentralized e-money and start with highlighting some of the key differences.

The main difference is that for decentralized e-money there is no formal issuer. There is no central bank, financial intermediary or Internet platform.

E-money is decentralized over a peer-to-peer computer network but directly links users, in which no one user assumes control for the e-money. Maybe a good analogy would be to think about an Internet chat room that links users, but no one user has control over it.

The standard example for decentralized e-money is the bitcoin. The bitcoin was created in 2009, and since then there have been about 200 other similar currencies. We call them crypto-currencies, and I will explain why in a second. Many of them have been created over the last few months, and a few of them have been since discontinued.

As the best-known example of decentralized e-money, most of my remaining time will be focused on the bitcoin, and I will close by illustrating similarities and differences between the bitcoin and other crypto-currencies.

Until the creation of the bitcoin, so until 2009, the very idea of decentralized e-money was theoretical, and multiple specialists would argue that it's unsolvable, that it's only a theoretical construct that couldn't be implemented in practice. The biggest problem there was the issue of double spending. Let me explain why.

Suppose we develop a crypto-currency or digital currency that I would like to sell to Grahame. As I send this electronic record to Grahame, the first thing he will need to do is verify that this record is authentic or valid. This step is relatively straightforward and there are some tools in information technology that allow for this step. In a sense, it's similar to taking a banknote and verifying it's not counterfeit.

Problems will arise when I try to convince Grahame that this record I'm sending to him has not yet been sent to somebody else before him. How do I convince him I have not already sent information — the money I'm sending to him? This is not an issue for banknotes, because once you spend them, they're gone; you cannot spend them twice.

Moreover, when we talk about centralized e-money, it's not an issue either. That's because there is a centralized issuer who keeps a ledger that summarizes who holds how much of a currency, and it's continually updated with transactions.

With bitcoin and some of the decentralized currencies, this ledger is shared on a peer-to-peer network, and because of cryptographic tools the network uses, its validity is trusted despite the absence of a trusted third party — an issuer.

From the point of view of technology, being able to spread the trust across a peer-to-peer network was a major innovation. This means there is no single issuer of bitcoins. The bitcoin itself is nobody's liability and, in particular, it's not redeemable. Because bitcoin uses cryptographic tools to achieve this, we call it "crypto-currency."

There is a lot more to learn about the technical aspects of bitcoin and similar currencies, particularly the cryptographic tools they use. We understand that you will be hearing from an expert in information systems engineering who will be better able to provide you with this information.

For our talk, we would like to focus on the question within our field of expertise, starting with whether bitcoins and, by extension, other crypto-currencies can satisfy the functions of money. We would also like to discuss how innovations such as bitcoin might contribute to improving the efficiency of our payment systems, while raising some issues for policy makers.

As we saw in the discussion of centralized e-money, there were some cases where it met the criteria of money: It was a medium of exchange, a unit of account and had a store of value. Again, one of the key examples would be the Octopus card in Hong Kong.

How does decentralized e-money such as bitcoin hold up? We would argue that bitcoin and other crypto-currencies fall short of a definition of money and do not satisfy the functions of money, at least at present. First, for bitcoin to be currency, it would need to be generally accepted and it would need to be a medium of exchange. While there may be some potential here, it's not quite there yet.

We do see that the bitcoin network allows and facilitates transfers of bitcoin users. We also see a growing group of retailers — some of them global — that allow purchases in bitcoin. Our search of bitcoin-related enterprises reveals that there are anywhere between 100 and 200 retailers in Canada who accept bitcoins for transactions. Worldwide, all my sources would estimate there are in the neighbourhood of 15,000 goods and services that can be obtained for bitcoins. These are perhaps large numbers, but at the same time, in the context of the overall economy, we would argue that these numbers are not quite enough to persuade people that bitcoin is at present a generally accepted means of exchange.

In terms of a unit of account, bitcoin may have potential but is not quite there. Even in those cases where bitcoin is a means of exchange, the underlying value of a transaction seems to be always in terms of a state currency, such as the U.S. or Canadian dollar. Such value would then be trusted into bitcoins for the purposes of a transaction.

This is true of most merchants who market themselves as accepting bitcoins. In practice, such merchants rarely actually receive the crypto-currency. Instead, they contract with third parties that exchange bitcoins into international currencies at the moment of exchange of the transaction. An example of a company that offers such services is bitbay, an Atlanta-based company that provides the merchant with the option of accepting bitcoins but receiving the equivalent payment in state currency via bank transfer from bitbay.

Finally, when it comes to the store of value, here again we would argue that bitcoin falls short. The key reason is the variability of prices in terms of international currencies. For example, a recent report estimates the volatility of the value of bitcoin is about 108 per cent per year. In comparison, it's about 40 times greater than the volatility of the real value of a U.S. dollar.

To illustrate this, consider that in 2010, bitcoin traded at a third of a cent per bitcoin. It reached a high of about $1,200 in December. I checked this morning, and it now trades at about $430 per bitcoin. Imagine you're a merchant and you're receiving bitcoins for the good and services you provide your customers. You wouldn't know how much those bitcoins will be worth next week or next month. A typical merchant wouldn't be comfortable to accept a medium of exchange that varies in value so much.

There's an anecdote that illustrates this. An unfortunate soul in 2010 exchanged 10,000 bitcoins for two pizzas worth about $30 at the time, and the bitcoins were worth a third of a cent per bitcoin. In today's exchange rates, those 10,000 bitcoins would be worth $4.3 million, making those two pizzas really overpriced.

This volatility of bitcoin means that customers who store value in bitcoin are exposing themselves to a lot of variability and a great deal of risk in terms of what the savings could be worth, even in a relatively short period of time, like a week.

Because of these reasons, some would argue that crypto-currencies such as bitcoin are perhaps better understood and characterized as speculative investments rather than as a source of value worth a division of money. Some experts and some of our peers such as the Bank of England and Bank of Finland would suggest bitcoin is more similar to a commodity than a currency.

I want to spend a little more time on the store-of-value aspect, because the price volatility of bitcoin and other crypto-currencies signals an important difference between them and state currencies issued by banks. Many crypto-currencies have delegated the management of the money supply to algorithms. In bitcoin's case, the money supply is growing at a pre-specified rate. It will eventually level and remain constant forever after.

This fixed supply is at least partly responsible for the volatility of bitcoin in the presence of viable demand. In contrast, one of the key roles that central banks play is maintaining the price stability in terms of state currencies and specifically preventing price volatility of the type we are seeing in bitcoin.

One of the tools that central banks have to achieve this goal is changing the supply of a state currency. This wouldn't be possible for bitcoin. Arguably, it was a feature that was attractive to some of the users of bitcoin, but we would argue it is a feature that has a negative consequence of contributing to price volatility. This volatility makes it difficult for bitcoin to be a reliable store of value and, consequently, a currency.

So if we argue that crypto-currencies at present don't really satisfy the key functions of money, why are they so popular? Why do we have them?

First, crypto-currencies may help reduce the cost of initial intermediation. Because they are decentralized, crypto-currencies sidestep the high cost of facilitating and processing electronic payments. That mediation is often expensive and too high for smaller-value payments to be processed, and this effectively limits the scope of e-commerce to higher-value transactions.

Another related feature that some consider positive is the irreversibility of payments. This allows crypto-currencies to look more like cash and allows merchants to accept payments for transactions without the risk that these transactions will be later reversed.

These two features, avoiding potentially costly intermediation and enforcing irreversibility of payments, could allow crypto-currencies and bitcoin, for example, to serve an important niche in the digital economy, and specifically for micropayments. Think about payments for individual songs over the internet or individual pictures. Such payments are too low to warrant merchants' investments in payment infrastructure or to justify the fees from existing instruments such as credit cards.

Finally, there's another feature of bitcoin's design that is attractive again, at least to some consumers, and that is the high degree of privacy, or to be technical, pseudonymity that bitcoin offers.

Transactions in bitcoin are publicly available, but at the same time, they do not reveal the transactor's true identity. Again, this feature was meant to make bitcoin more similar to cash and cater to consumers who value their privacy. However, as with cash, there are disadvantages of allowing such anonymity.

As we have seen, bitcoins can be stolen or defrauded from the owners. Moreover, the novel features of bitcoin, such as anonymity, irreversibility of transactions, makes it professionally attractive to people who are interested in, say, trading illicit substances or professional money laundering, particularly over the Internet.

I believe our colleagues from the Department of Finance have already discussed some of these issues with you.

[Translation]

As I said earlier, bitcoin is the cryptocurrency we hear about the most often, but there are many others. Some of these have different features that try to improve perceived shortcomings, while others just copy the original formula under a different name.

I will give you a few examples. One such cryptocurrency, litecoin, was developed in 2011, largely based on bitcoin's specification. Some changes were introduced to try to improve the speed of transaction confirmation, the settlement, and the size of the total money supply was increased fourfold compared to the bitcoin. At present, litecoin is the second most popular cryptocurrency in terms of market capitalization.

A perhaps more interesting example is peercoin. This cryptocurrency is much less popular than bitcoin or litecoin, but it offers some distinctive new features. First, there is no hard limit on the total number of peercoins. Instead, the money supply will increase by one per cent per year. Second, the newly minted peercoins are partly awarded to users who do some particular tasks within the system, much as in bitcoin or litecoin, but also to existing holders of peercoin. Roughly speaking, if you hold one per cent of peercoins, your stake entitles you to one per cent of newly minted peercoins. You may perhaps think about this as a dividend accruing to existing stakeholders.

Finally, another cryptocurrency called the ripple, is a good example of how quickly e-money is developing and how fluid the concepts and definitions are. Ripple is based on technology similar to bitcoin, and thus is often referred to as a cryptocurrency. However, it is controlled by a third party, Ripple Labs, which issues the currency — in Bitcoin lingo, the ripple is pre-mined. Importantly, Ripple Labs refers to the ripple as a "payment system, currency exchange, and remittance network" rather than money as in a generally accepted means of payment. This payment system is meant to allow users to trade a range of currencies, including other cryptocurrencies, remit money, et cetera, making it more of an e-payment system than e-money, strictly speaking.

Beyond these few cryptocurrency examples, there are perhaps 200 others. Most of them have a relatively small consumer base, and a few are all but defunct after a brief spike of interest.

[English]

In closing, any discussion of e-money needs to take a balanced view of the weaknesses and potential risks of these innovations and economic benefits. These benefits arise from payment needs that e-money satisfies. As long as the needs are there, even if bitcoin or similar crypto-currencies ultimately fail, other payment innovations will rise to replace them.

One thing that history has shown us is that changing consumer needs, changing technology, will be reflected in innovations in payment systems. Such innovations may well be based on the technology that is similar to that underlying bitcoin. They may be implemented not only in a decentralized fashion like bitcoin but perhaps also incorporated into products or services offered by private companies or maybe even governments.

Now, the payment landscape is changing rapidly, both in Canada and around the world, with a number of innovations, participants and systems. At the Bank of Canada, we cannot predict the exact direction that this innovation will take. However, what we can do is assure the committee that we'll continue our efforts to monitor developments and assess implications. We will share our findings with Canadians through publications on our website.

Thank you very much.

The Chair: Thank you, Mr. Johnson and Mr. Pomorski, for your opening presentations. They were very helpful.

We have just over 35 minutes left for questions. I have a long list of questioners, so I will ask that you keep your questions sharp and to the point.

[Translation]

Senator Bellemare: Thank you for your presentation. As you know we began studying the bitcoin because we are interested in cryptocurrency. We understood that there were some differences, as you explained, between e-payment methods and cryptocurrency.

My question relates to conversion. As compared to other methods of payment, the innovation of the bitcoin and similar currencies is very much linked to the possibility of conversion, but at the same time that is what causes it to fluctuate, and that is what makes this currency very volatile.

We also see that this payment method is used quite a bit, with the globalization of e-commerce and Tesla, and we wonder why Tesla. Would a country that exports a lot of goods and would like to encourage global transactions have an interest in starting production and promoting digital money like bitcoins? It could be called something else and in a way offer a certain guarantee to allow its convertibility and prevent the volatility of the currency. Is that something we could think about? And what do you think about it, as a representative of the Bank of Canada?

[English]

Mr. Johnson: I will make a couple of points. Generally, those countries that are active in global trade would support advances that make cross-border international payments faster, more secure and cheaper. That would tend to facilitate this.

I should stress that at this stage these methods of payment are largely person to person. Obviously, a lot of exporting is business to business with a reseller buying from a supplier — one business buying from another business to resell. There has been relatively little in the way of crypto-currency activity in that. Letters of credit are quite important for global trade. There's no credit in crypto-currencies, making trade difficult. A very good question about the price volatility, as Lukasz pointed out, is that at this stage it's one of the key things that stands to make bitcoin and other crypto-currencies not fully meet the definition of "money."

In order to mask the volatility, you would need to control the supply of the money. If you have a given supply of goods or a given level of economic activity that fluctuates and you want to keep the price level constant, the amount of money needs to fluctuate. I would say that the Bank of Canada and most other central banks have set an inflation target as a way to achieve that. We will manage the money supply, as such, and the interest rate to keep the value of the Canadian dollar relatively stable in terms of goods.

That is contrary to the very foundation of a crypto-currency with a fixed supply. As in bitcoin, that's impossible. By definition, if the level of economic activity in trade fluctuates but the supply of crypto-currency does not, you will have volatility. That's certain and significant.

[Translation]

Senator Bellemare: Do you not think that the speed of circulation of that currency could increase? Could we not see a situation where the speed of bitcoins might differ from the circulation rate of ordinary currency?

[English]

Mr. Johnson: Yes, it certainly could be, but not a monetary thirst. The velocity of money is extremely volatile and difficult to predict. It can move around rapidly and lead to large fluctuations in the relative price of goods in a certain currency. The price of goods denominated in bitcoin is extremely volatile, and part of that would be rapid changes in the velocity.

Mr. Pomorski: I would add to that. I would always try to look at the underlying economic needs that the currency might serve. I agree with you that perhaps the greatest needs are actually at the level of remittances or sending money abroad. To the extent that people are not satisfied with the current offering of economic services, they might gravitate to services such as crypto-currencies. To the extent that crypto-currencies can provide lower fees for these services, they might be adopted eventually.

I want to make two points that I think are important. First, if you develop a system to cater to this need for remittances, then this is more a payment system than a currency. You're not issuing a currency; you're providing a service for this particular need. In fact, one of the examples that I mentioned was ripple. The designers of that system were specifically identifying the area of international remittances as one of the key features of their business model. At the same time, they were very clear that what they have is not currency; it is not money. They provide a way to send money abroad cheaply, maybe more cheaply than other methods. In this sense, I think similar innovations may have a role, but it wouldn't be a role of currency.

[Translation]

Senator Hervieux-Payette: You spoke earlier about M-Pesa in Africa, and about Octopus, in Japan. You say that this method is used by countries that have a less developed system. Can you tell us more about that? What do you mean by a less developed system?

Mr. Johnson: Could you repeat that question?

Senator Hervieux-Payette: In your presentation you talked about a system in Africa that is called M-Pesa and about a system in Japan that is called Octopus. You say that this method of payment or transaction is more useful for less developed systems. Less developed as compared to what? We have a developed system and so we would not need it, whereas other systems could benefit? Could you explain to us where we are located in that system, developed or not.

[English]

Mr. Johnson: We referred to systems. Canada is a very good example in this regard of a country with a very well-developed payment system with technology that is provided by major institutions. It is very good. I don't know the number exactly but a huge percentage of Canadians are what we call "banked," i.e. they have bank accounts with large institutions. When you're banked, you have things like debit cards, credit cards and this method of payment.

In Africa, for example, a very small percentage of the population has a bank account. A payment system such as M-pesa helps to accommodate in that you don't need a bank account. You can load monetary value on M-pesa and use that as a means of exchange.

I mentioned the tools that give access to your demand deposit to exchange. If you do not have a demand deposit, if you're in a country that's not well banked, an access tool does you no good; so you need a store of monetary value.

As for the Octopus card, I'll turn to Lukasz.

Mr. Pomorski: The point I was making is that the Octopus card was designed specifically for the mass transit system. Within a few years, it gained widespread adoption across a variety of retail establishments, not only transit. Since then, there were two similar innovations, one in the U.K. with the Oyster card, and one in Canada with the PRESTO card. Technologically, they are very similar. You can store value on them and potentially use the value not only for rides on a transit system but also for purchases.

Somehow in Hong Kong these cards became used for a variety of purposes, but in both the U.K. and Canada they haven't and are used almost exclusively for transport. I would interpret it this way: As Grahame said, we already have a payment system that caters to the needs that such cards might satisfy. For example, debit and credit cards allow you to pay for coffee or a newspaper in the blink of an eye. Perhaps in Hong Kong those new devices were competing for people looking for this convenience, whereas in Canada that niche was already filled.

Senator Hervieux-Payette: People pay for the transportation card in Canada. This is what we use for a monthly transit pass. Money is involved in that.

Mr. Pomorski: I agree. The key difference is that we're using a PRESTO card only for this one use. I would go back to the defining feature of money as being "generally accepted." If you're using this card for only one service, I wouldn't call it money. In Hong Kong, it's actually used for a broad range of services.

As other examples, we could talk about stored value cards issued by Bridgehead or Starbucks. These cards are used exclusively to buy coffee or whatever else you buy at Bridgehead or Starbucks. They're not used outside the chain.

Air Miles can be used for a variety of services, in particular for airplanes but also for goods specifically from one provider. You cannot take your Air Miles card and go to Walmart to buy goods. Because of this, the Air Miles card would not qualify as money. These cards are not generally accepted means of payment.

Senator Black: You've been very helpful in advancing our study. My line of questioning this afternoon will focus on opportunities that might flow from this innovation. I would start by asking if you would agree with me that bitcoin is an innovation, not the endgame.

Mr. Johnson: Yes, I would agree with that. I think we would agree with that.

Senator Black: And you would agree as well?

Mr. Pomorski: Yes.

Senator Black: From that point of view, then, how might we in Canada — and we will get specifically to your role in my next question — be able to harness the positive aspects of these currencies while mitigating downfalls? Can you offer your views on that, please?

Mr. Johnson: Again, coming back to a distinction we made in the opening remarks and one Lukasz made, to use bitcoin as an example, there's a difference between the big "B" Bitcoin which is the network. That is, this underlying technology that allows verifiable payments without a trusted third party to go very cheaply, which really was quite a material breakthrough in computer science, in my understanding at least. Then there is small "b" bitcoin, which is the currency that it uses right now.

I think there's no doubt that the payment system technology underlying this was a material advance, as you said, senator. It is an advance; it is not the endgame. It showed that what seemed to be unsolvable isn't, so there will be more work done on this. In terms of payment system efficiency, absolutely these are good advancements.

The question of how you harness it, while at the same time protecting people, is one that, quite frankly, we will spend a lot of time on. We have not really formed solid opinions on that. To date, it is largely a consumer protection education aspect — even the education of the volatility of the underlying currency. The price is volatile and it is not broadly accepted. As I said, that seems to be the biggest issue right now. Quite frankly, it is something that falls outside of the Bank of Canada's mandate. Again, we will advance our research on this.

Senator Black: A work-in-progress?

Mr. Johnson: A work-in-progress, much like the system itself.

Senator Black: Absolutely, and that's appropriate.

Can you see a circumstance where the Bank of Canada would issue e-money?

Mr. Johnson: There is a question. The Bank of Canada issues Canadian dollars under the Currency Act. That is the legal tender of the Government of Canada and the Bank of Canada is the sole issuer of that, so we issue Canadian dollars.

Under the current legal act, we couldn't issue another currency. In terms of a digital currency, it is not under the current legal framework.

The e-money or e-payment system is different. We currently do not. We could have made the decision to offer demand accounts to Canadians, which we did not. We could have made the decision to offer debit cards for those demand accounts to Canadians, which we did not. The decision, well before either of our times, was clearly that this level of innovation and scale and customer service was best left to the private sector in an appropriate regulatory framework. I think that has served Canadians very well, going back to the fact that we have not seen a lot of this sort of Octopus card or M-pesa. Canadians are well-served by their payment system technologies now.

Senator Black: Are you shutting the door to the question?

Mr. Johnson: No. Again, as I said in my opening statement, one of the key questions we're looking at is this: What is the role of the central bank?

Senator Black: I'm advised that there is something called MintChip.

Mr. Johnson: A great name; mint cookie.

Senator Black: I'm told the MintChip is being developed by the Royal Canadian Mint as a digital currency backed by the government. Can you comment?

Mr. Johnson: I would actually defer that to the Mint.

Senator Black: You would as well?

Mr. Pomorski: I also would defer that comment. I can tell you that we are in communication with our colleagues at the Mint who are working on this, or working on this innovation, but I would be out of line if I were to comment on this on behalf of the government.

Senator Black: Are my researchers close to right? Do you understand that that might be the case?

Mr. Pomorski: In terms of the product that was being developed, it was essentially a centralized e-money development similar to the ones that I was talking about in my presentation; so you're right. This is one of the examples of where an institution might go in issuing e-money.

Senator Black: Where Canada might go?

Mr. Pomorski: Yes, where Canada might go. It's certainly a possibility. It has been evaluated by the Mint, but again I will stop short.

Senator Black: I understand.

The Chair: That's a very good try, senator.

Senator Massicotte: Senator Black, in the last statement you sounded like a journalist trying to pry something out of somebody.

[Translation]

We are not experts, and several of our discussions are aimed at allowing us to learn a bit more about the nature of bitcoins and that type of currency. According to what I have read, I am convinced that this can never become the national currency. If only in terms of monetary policy, why would the government lose control over one monetary policy?

As a currency, as a means of exchange, does it have any usefulness? There are a lot of them in circulation. We are told that it costs very little from the point of view of issuing the technological message, but it has to be purchased from an exchange and that currency has to be used to purchase a product; it costs something. If you buy the currency from someone, it is relatively expensive; I checked that out this afternoon. And when you add that fee to the product, there are so many variations in its value that you may think you are saving money, but on the contrary, you have paid 5 per cent or 10 per cent more because it is not recognized, and you do not know that. And, there is something else, regarding the high degree of privacy; we were advised that that is not the case. As with Internet, you can check. So what is its future utility? It is popular currently, there is a way of marketing it to suppliers, but what is our role? Do the government and the Bank of Canada have a moral obligation to protect those who own some? What are your comments on that?

[English]

Mr. Johnson: I think we both said that, in any area, looking into the future is extremely difficult, especially one this rapidly changing.

You make a good point about the importance that governments place on maintaining control over money. It's a very valuable tool. Obviously, for the Bank of Canada it is a very valuable tool for economic management.

In terms of the utility that bitcoin brings, I would again distinguish between the big "B" Bitcoin payment system and the small "b" currency. As we have seen, payment systems evolve over time. They generally allow for transactions to take place simpler, faster and cheaper and there continues to be a progression along that. This is clearly a step along this road. The transactions are quite quick, reversible and can be done much more cheaply than in a lot of other areas that use trusted third party providers. That may well be the most fertile ground for future work here. What you said about the price volatility making it difficult as a means of exchange is very true. Lukasz's example of the $6 million pizza is a good one.

I'll turn to Lukasz in a second, but one reads and hears about these 15,000 merchants, or however many, that accept bitcoins. But they don't really. They accept it and then instantly turn it into a national currency, such as a U.S. dollar, a euro or a Canadian dollar, for exactly the reason that you said, sir: There's zero interest in holding this for even a day because of it.

In effect, people can use the Bitcoin payment network by waiting until the very last minute. You go online, you wish to purchase something, you wait until the very last minute to buy your bitcoin, immediately pay with it, and the vendor immediately turns it back into Canadian or U.S. dollars. You've used the big "B" Bitcoin network and minimized your exposure to the small "b" bitcoin currency, which again is a possibility.

We don't have a crystal ball, but these are some of the potential advantages the system offers.

Senator Massicotte: I'm not optimistic on the small "b" bitcoin. It's probably because I don't understand it. I agree the technology is phenomenal. It probably could be used for registration of other assets or even real estate. But in a small "b" sense, I don't see much of a future. Also, my reading is that 80 per cent of the holders are speculators. It's more of a commodity than a currency. As you know, income tax wise —

Mr. Johnson: And some have used it that way.

Senator Massicotte: The U.S. and Canada are saying that exactly: It's a prop.

Having said that, do we have a responsibility as a government to deflate this balloon, like China? What do we do? I think Senator Tkachuk said last week that if 80 per cent are speculators, they have a right to. Why should we care? Why should we try to protect anybody? It's "buyer beware." People know it's a highly variable currency, so maybe there is no role for the government other than to say, "Be very cautious; be careful."

Mr. Johnson: Financial consumer education is an important role. Much of the interest in bitcoin in the early adoption was — and I know this was covered in previous sessions — a sort of libertarian view of "get away from state currencies." Once it started to move, much of the interest did become speculative. There is nothing wrong with speculation, and I don't think it's the role of the government to protect anyone from known speculation.

There is an important role of consumer protection at this stage. It is at least portrayed as a currency, so perhaps it needs to be made clear that this is not Canadian currency and the Canadian Deposit Insurance Corporation does not stand behind this; you're not in a bank. Consumer education has a role.

From the Bank of Canada's view in terms of economic and systemic risks, it's far too small. The amount of bitcoins in Canada is far too small to be economically or systemically important at this stage. That doesn't mean it won't become that way. Again, my point is that this is a work-in-progress; this will evolve. If it gets several orders of magnitude bigger, would the story change? Potentially, yes, and it again speaks to the fact that we're following this closely, and it's an activity research agenda item.

The Chair: Are there further questions?

Senator Campbell: Do you think we would be even looking at this if there hadn't been Silk Road? It sort of captured our attention. It has all the makings of a great spy movie, but do you really think we would be here if it wasn't for that?

Mr. Johnson: That's a very good question. Certainly the backstory behind bitcoin is fascinating, with the "Dread Pirate Roberts," the guy who ran Silk Road. Even with Mt. Gox and the subsequent collapse there, the backstory is interesting and certainly makes for good journalistic coverage. It has accelerated.

Would we be looking at it? We certainly would. The Bank of Canada held a conference on e-money two years ago, before bitcoin was really in the common lexicon. This is a material advance in money and payment systems, and it's something we need to understand. The Bank of Canada has a currency department. We have been studying alternative means of payment for 30 years, probably even longer.

I had comments about the risks to the bank of demand for cash falling off precipitously and that this would have impacts on the Bank of Canada's balance sheet, which would have knock-on effects. These worries existed when credit cards came out and then when debit cards came out. You could look at it and wonder if everyone has a credit card and debit card, wouldn't the demand for cash collapse? It never did. Banknotes outstanding goes up 5 per cent per year and does so every year, in line with nominal GDP growth. It has for the past three decades.

We pay a lot of attention to this; we have paid close attention to every advancement in the payment system — credit cards, debit cards and automatic cheque clearing — and we will continue to do so with this.

Mr. Pomorski: I would add that I wouldn't necessarily trivialize bitcoin or other similar currencies. It's easy to do so —

Senator Campbell: All of a sudden, it went from being off the radar to reading about it every day.

Mr. Pomorski: I do take your point. Unfortunately, perhaps a lot of attention is driven by things like Silk Road or colourful names. But at the same time, I would bring this back to a question. You mentioned regulation and should we be regulating that innovation. It's always a question of a trade-off. What is it about bitcoin that we want to regulate? Is there a systemic issue? We don't see any. So at present, the only dimension is consumer protection. There is also the other side of the trade-off, which is the gain to our economy and our consumers who may be using these tools for particular needs and goals.

Let me offer one example on this point. One of the features of crypto-currencies that are often considered nefarious is anonymity. They are nefarious for very good reasons. But at the same time, suppose you want to transact with a merchant based in Poland. I will use this example because I am of Polish origin. How comfortable would you be to send your credit number and address to a merchant based in that country? You might not be very comfortable. It doesn't have to be bitcoin; it could be whatever else. But these developments have a role in providing a way to transact with a merchant in Poland, say, without revealing who you are, where you live and what your credit card number is. Even things like anonymity have a role. Some consumers are looking for that.

Senator Campbell: My second question relates to Octopus. I had an opportunity to meet with the board of Hong Kong Transit. In Vancouver, we were looking at this type of card. I brought this up with them about the transit card. The reason it branched from transit into other areas for them is because such a high level of the population uses public transit that it is natural to have this card, whereas in Canada it's not that large.

So transit actually looked forward on this and started with this, but realized they captured this huge part of the population. Octopus would like to come to Canada. When we looked at it, we thought it wasn't going to get the lift. They were clear on that; they had a captive audience, and they were going to push this card. And it's hugely successful.

The Chair: We will conclude with a very brief question from Senator Bellemare.

[Translation]

Senator Bellemare: I wanted to know, in terms of figures, what the Canadian money supply is, in billions, as compared to the bitcoin supply.

Senator Hervieux-Payette: Sixty-three, they said that at the beginning.

[English]

Mr. Johnson: I'm not an expert in money supply, and there are a lot of definitions of it. I would have to come back to you.

In terms of currency outstanding, it's 63 or 64 billion right now in terms of banknotes outstanding. In terms of M1 —

Mr. Pomorski: I wouldn't go to M1. I would try to compare apples to apples if you talk about a specific currency.

Talking about the money supply of bitcoin in terms of U.S. or Canadian dollars is tricky because those numbers are changing rapidly. As of today, the money supply of bitcoin is of the order of $7 billion globally, which is 100 times smaller, roughly, than the money supply of cash. So not money supply, but supply of banknotes in Canada, Canada alone. You may want to add to this the supply of — if I am correct — $1.2 trillion worth of banknotes that the U.S. emits.

In terms of the importance of bitcoins at the moment in the global system, it's relatively unimportant, which perhaps explains why we haven't seen, in terms of a systemic impact, any evidence that it might have an impact at the moment. It does have an impact for consumers, for individuals who transacted, often with high risk to their wealth, but not systemically. Not in Canada, and certainly not worldwide.

Senator Massicotte: Having said that, right now there is a delay of around 10 minutes for every transaction. It's growing a little bit. Is the technology even available to do international currency?

Mr. Johnson: There is a delay. Bitcoin is not instantaneous, obviously. The miners have to verify it, and the ledger has to be updated, and it can take an hour to do a full chain.

Senator Massicotte: Because you've got to do it all again —

Mr. Johnson: The other thing that advances as quickly is the amount of computing power devoted to this. I don't think we have it with us, but you can see graphs that show essentially the hash rate or what is referred to essentially as the network computing power. This is a peer-to-peer network. Gone are the days when you could hook your laptop up and mine bitcoins. These are now special-purpose, dedicated machines that are extremely powerful. More and more get on the network every day. The amount of computing power devoted to this has gone asymptotic as well.

I think it has been a bit of a draw so far.

Mr. Pomorski: I would finish off by offering one statistic. At present, there are about 40 transactions in bitcoin per minute as compared to maybe 200,000 transactions on Visa alone. I'm not an expert to answer the question as to whether bitcoin could be, in principle, able to handle that volume of transactions.

One thing that I would be very careful about is that bitcoin is not the only innovation. In fact, at least one of the examples that I gave you — I think it was the litecoin — actually is designed in a way to cut the settlement time to a quarter.

The Chair: Most interesting, but our time is coming to an end. On behalf of all of the members of our committee, I would like to express great appreciation for your presentations today.

You have talked about the work-in-progress for the Bank of Canada. You can see it's also very much a work-in-progress for the committee, and I suspect we will look forward to having you back.

Members of the committee, if I could have you stay for five minutes for an in camera meeting.

(The committee continued in camera.)